Investors in China’s mainland stock markets look set for another bumpy ride next week after Beijing cut interest rates on Saturday, facing-off with stock market pundits who say equity valuations are too high.
China’s central bank said on Saturday it would cut rates by 25 basis points and trim the reserve requirement ratio for financial institutions.
“The government appears eager to maintain a bull market to expand the capital market and reduce reliance on bank lending, although the use of monetary policy for that purpose is questionable,” said Lan Shen and Shuang Ding, economists at Standard Chartered in a note to investors on Saturday.
The People’s Bank of China (PBoC)’s move follows a 7.4% drop in Shanghai’s stock market to 4,192.87 points on Friday about 19% off this year’s high hit on June 12. A bear market is commonly defined as a greater than 20% drop in market bench markets over at least two months.
“The balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and Chinext has now taken place,” said Morgan Stanley chief Asia strategist Jonathan Garner in a report released Friday citing increased equity supply, weak earnings growth in the context of economic deceleration, high valuations, and very high margin debt to free float market capitalization.
He said while its true Chinese authorities have been vocal in their suport of the rally “governments are not able to exert direct control over stock market behaviour, in particular where trading volumes, valuations and margin leverage are as stretched as they are now in China”.
More than 40% of Shanghai-listed stocks by number are now trading at over 80 times historical earnings, higher than when Chinese equities peaked in 2007.
The biggest tumble in Chinese shares since 2008 is proving especially painful for margin traders as their favourite stocks sink faster than the benchmark index, raising the risk of forced liquidations.
The 30 equities in Shanghai with the highest levels of margin debt relative to tradable shares have dropped 17% on average since the market peaked on June 12, versus a 13% decline for the Shanghai Composite Index. Margin positions on the city’s bourse fell for the first time in a month on Friday, a sign that leveraged investors are unwinding bets after they grew more than five-fold in the past year.
With at least $364bn of borrowed money riding on stocks in Shanghai and Shenzhen, losses on those positions threaten to magnify market declines as traders sell shares to meet margin calls. China’s benchmark index tumbled at the fastest pace among global equity gauges last week, after a world-beating 152% gain in the previous 12 months.
“It’s a self-fulfilling prophecy,” Roshan Padamadan, the founder and manager of Luminance Global Fund, said in an interview on Bloomberg Television from Singapore. “As people try to book profits, they’ll find out that there’s nobody on the other side of the trade.”
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